Western Alliance Bancorp
NYSE:WAL
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Western Alliance Bancorp
Earnings Call Analysis
Q2-2024 Analysis
Western Alliance Bancorp
Western Alliance Bancorporation's second quarter of 2024 showcased impressive earnings of $1.75 per share, signaling a robust start as the company transitions from a repositioning strategy to an earnings growth strategy. The strategic balance sheet growth during the quarter was pivotal, leading to a significant rise in net interest income due to the deployment of increased liquidity into higher-yielding assets. Core deposits grew by an exceptional $4 billion, while loans held for investment increased by $1.7 billion, marking a 14% annualized growth rate compared to the first quarter.
The company significantly bolstered its liquidity profile with a $1.7 billion rise in securities and cash. This increase facilitated a reduction in borrowings by $634 million and brokered deposits by $222 million. The Common Equity Tier 1 (CET1) capital ratio remained strong at 11%, reflecting a solid capital base. Western Alliance's distinct national commercial banking model continues to sustain deposit growth and position the bank to deploy liquidity effectively into low-loss commercial and industrial (C&I) loans, leveraging its expertise in various sectors.
The asset quality of Western Alliance is normalizing as expected, with total classified assets declining by $33 million. Net charge-offs stood at 18 basis points of average loans, predominantly attributed to previously identified troubled properties in Downtown San Diego. Encouragingly, the bank's renewed earnings power is expected to compound capital consistently and support risk-adjusted earnings growth, underpinning a projected earnings uptrend for the third and fourth quarters as previously communicated.
The quarter saw a 39% annualized growth in net interest income driven by higher average earning assets and an expanding net interest margin (NIM). The rising balances compared to averages set a favorable stage for increased net interest income moving forward. Western Alliance forecasted that loans would grow by $4.5 billion for the full year, exceeding the prior $4 billion estimate. Deposit growth expectations have been revised upward by $3 billion to $14 billion. The CET1 ratio is projected to stay at or above 11%, while net interest income is anticipated to rise by 9% to 14% from the annualized Q4 2023 baseline, including two expected 25 basis point rate cuts.
Noninterest income for the quarter dipped to $115 million, mainly due to lower equity investment income and softer mortgage revenue. However, there was a notable increase in mortgage loan production by 14% and a 24% rise in interest rate lock volume, although the gain on sale margin decreased slightly. Noninterest expenses rose primarily due to higher deposit costs, yet the mortgage warehouse lending group's market share gains resulted in net interest income growth surpassing the increase in deposit costs by $21 million.
Western Alliance's operational efficiency, reflected by a 52% adjusted efficiency ratio, benefitted from net interest income growth. Despite an uptick in special mention assets, overall asset quality remains normalized. The bank's focus on stringent credit policies and proactive risk management continues to position it favorably within the industry. Moreover, Western Alliance's diversified deposit channels and continuous traction, particularly in the Juris Banking and consumer digital segments, are expected to maintain strong growth in deposits carrying no direct or imputed interest costs.
Western Alliance Bancorporation's Q2 performance underlines a positive trajectory marked by strategic growth, robust capital management, and a commitment to maintaining superior asset quality. Moving into the latter half of the year, the company anticipates a continued rise in net interest income in Q3 and a stable outlook for Q4. The projected incremental rise in commercial banking fees and other income streams, alongside tightly controlled expenses, supports an optimistic outlook for sustained profitability and operational growth.
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Good day, everyone. Welcome to Western Alliance Bancorporation's Second Quarter 2024 Earnings Call. You may also view the presentation today via webcast through the company's website at www.westernalliancebancorporation.com.
I would now like to turn the call over to Miles Pondelik, Director of Investor Relations and Corporate Development. Please go ahead.
Thank you. Welcome to Western Alliance Bank's Second Quarter 2024 Conference Call. Our speakers today are Ken Vecchione, President and Chief Executive Officer; and Dale Gibbons, Chief Financial Officer.
Before I hand the call over to Ken, please note that today's presentation contains forward-looking statements, which are subject to risks, uncertainties and assumptions, except as required by law. The company does not undertake any obligation to update any forward-looking statements. For a more complete discussion of the risks and uncertainties that could cause actual results to differ materially from any forward-looking statements, please refer to the company's SEC filings included in the Form 8-K filed yesterday, which are available on the company's website.
Now for opening remarks, I'd like to turn the call over to Ken Vecchione.
Thank you, Miles. Good morning, everyone. I'll make some brief comments about our second quarter earnings before turning the call over to Dale, who will review our financial results in more detail after I discuss our updated 2024 outlook. Tim Bruckner, back by popular demand, our Chief Credit Banking Officer for Regional Banking will join us for Q&A.
Western Alliance earned $1.75 per share in the second quarter and demonstrated the bank's building momentum as our repositioning strategy has transitioned into earnings growth strategy. Growth will be accompanied by an elevated risk management architecture as well as enhanced liquidity profile and capital base. Thoughtful balance sheet growth in Q2 drove an upward inflection in net interest income from increased liquidity deployment into higher-yielding earning assets. We generated outsized core deposit growth of $4 billion and HFI loan growth of $1.7 billion or 14% on an annualized basis from Q1, which we expect will exceed our peers. CET1 capital remained at 11%. Deposit growth in excess of guidance lowered our HFI loan-to-deposit ratio by 2 points to 79%. Our liquidity profile was also bolstered by a $1.7 billion increase in securities and cash from quarter end, which allowed us to pay down borrowings by $634 million and broker deposits by $222 million.
Our differentiated national commercial banking franchise uniquely positions us to generate sustained deposit growth from various business lines and deploy this liquidity into attractive, from no to low loss C&I commercial loans where we have deep segment and product expertise. Asset quality overall is normalizing, which we expected. Total classified assets declined $33 million in the quarter to 93 basis points. Net charge-offs were 18 basis points of average loans, the majority of which relates to the Downtown San Diego office property we identified on this call a year ago when it migrated to substandard. I think it's also important to note the renewed earnings power of our franchise strengthens our ability to consistently compound capital and generate risk-adjusted earnings growth to support the Q3 and Q4 earnings ramp we had previously communicated.
For the quarter, net interest income grew 39% annualized driven by higher average earning assets and an expanding NIM. Annualized deposits and HFI loan growth of 26% and 14%, respectively, pushed net interest income higher. Higher ending balances compared to average balances establishes a higher jumping off point to increase net interest income going forward. In total, pre-provision net revenue adjusted for the FDIC special assessment in Q4 and the rebate in Q1 is 22% annualized, and is poised to continue its upward trajectory.
At this point, I'll turn the call over to Dale for a review of the financial results.
Thanks, Ken. During the second quarter, Western Alliance generated pre-provision net revenue of $285 million, net income of $194 million and EPS of $1.75. Net interest income increased $58 million from Q1 to $657 million due to higher average earning asset balances and yields. Noninterest income of $115 million decreased $15 million quarter-over-quarter, primarily from lower income from equity investments as well as softer mortgage revenue. Mortgage loan production rose 14% and interest rate lock commitment volume increased 24%, while the gain on sale margin compressed by 3 basis points.
Noninterest expense was $487 million, deposit costs of $174 million growth in quarter-over-quarter increase to find attractive loan growth amidst an elevated rate environment. Net interest income growth exceeded the increase in deposit costs by $21 million this quarter as mortgage warehouse deposit growth continues to benefit from market share gains amidst industry disruption in the first quarter. We believe Western Alliance's warehouse lending group has become the premier bank in the space.
Considering our enhanced liquidity profile, we are well positioned to proactively lower the ECR cost of these deposits as the first rate cuts approaches. Provision expense of $37 million resulted from loan growth above industry trends as well as $23 million of net charge-offs. Securities and cash increased $1.7 billion quarter-over-quarter and allowed for a further $634 million reduction in period-end borrowings. Loans held for investment grew $1.7 billion to $52.4 billion while deposits increased $4 billion and $66.2 billion at quarter end.
Finally, tangible book value per share continued its expansion, rising 3% or $1.49 from March 31 to $48.79. Loan growth was primarily driven in the C&I categories of $1.9 million, which offset continued purposeful reductions in residential and consumer loans of $179 million in construction and land of $69 million. Mortgage warehouse, tech and innovation and fund banking loan growth [ grow ] Loan mix diversification while we reduced our CRE concentration. On a year-over-year basis, C&I loans have grown $5 billion.
Deposit growth of $4 billion was led by mortgage warehouse and followed by growth in Juris Banking and our digital consumer channel. Non-ECR, noninterest-bearing deposits have posted 3 consecutive quarters of growth and we are encouraged by the traction our diversified deposit channels are gaining, which should continue to drive growth in deposits that carry no direct or imputed interest cost.
Turning now to our net interest drivers. The yield on total securities increased 21 basis points to 4.87, recapturing 2/3 of the prior quarter's decline from HQLA build since conducted in the first quarter. Completing our accelerated liquidity build related to larger balance sheet repositioning efforts allow us to add more higher-yielding securities. Our liquidity position remains solid and unencumbered high-quality liquid assets were 53% of securities and cash compared to 52% last quarter. Securities and cash in total held steady at 26% of assets.
HFI loan yields increased 2 basis points due to asset repricing benefits from the ongoing higher rate environment. Back weighted loan growth momentum led to period-end loan balance exceeding average balances by $1.7 billion. The cost of interest-bearing deposits was 6 basis points higher from the first quarter while the total cost of funds declined 3 basis points to 2.79% due to a deposit mix shift toward noninterest-bearing and a paydown of short-term borrowings.
In aggregate, net interest income increased $58 million from higher average earning asset balances, which includes a full quarter's impact of the deployment of liquidity into securities towards the end of Q1 as well as a 3 basis point decline in the cost of liability funding.
Net interest margin expanded 3 basis points from the first quarter to 3.63% from the $5.9 billion increase in average earning assets as the growth was funded more from noninterest-bearing liabilities this quarter. Our adjusted efficiency ratio for the quarter was 52%. Net interest income growth is the primary contributor to this improvement. Deposit costs increased $37 million from higher average ECR-related deposit balances. As noted earlier, these higher balances funded commercial loan growth and purchase floating rate securities that propelled strong net interest income growth. Other operating expenses were essentially flat quarter-over-quarter.
As Ken mentioned earlier, asset quality continues to normalize. Total classified assets declined $33 million in the quarter to 93 basis points of total assets. Nonperforming assets were essentially flat from last quarter. Just under 2/3 of NPLs are paying as agreed when excluding the San Diego property that Ken cited earlier, which we expect to move into other real estate.
Turning to Slide 12. Quarterly loan growth -- quarterly net loan charge-offs were $22.8 million or 18 basis points of average loans. Most of the charge-offs this quarter were attributed to the San Diego office properties. Provision expense of $37.1 million cover net charge-offs and added reserves in concert with loan growth. Our allowance for funded loans increased $12 million from the prior quarter to $352 million.
Total loan ACL to funded loans ratio of 74 basis points was unchanged and covers 97% of nonperforming loans. Our focus on growing loans is indicating low-loss categories has resulted in a reserve levels lower than some years.
Slide 13 slows our ACL lift from 74 basis points to 132 when incorporating the effect in credit-linked notes, which insulate us to first loss credit unencumbered credits as well as loan no-to-low-loss categories like equity fund resources, our low LTV residential portfolio and mortgage warehouse loans.
More specifically, for the credit-linked notes, we have in our possession, $447 million from insurers that we did conduct first losses on an $8.9 billion mortgage portfolio leaving us with 0 loss risk. For our residential loans not covered by insurance, these mortgages have an LTV at only 62% at origination, which is slightly lower now to borrowers with FICO scores of 766 and debt-to-income ratios of 33% and have incurred no losses.
For EFR capital call loans and mortgage warehouse credit, not only have we ever had a loss, but other banks have had pristine credit experience as well. We include this in a locked up for the ACL because we have a large proportion of our book in the very low risk categories and other institutions.
Our reserve level is supported by our low realized losses. We have consistently discussed our proactive mitigation strategy, along with our low advanced lending discipline, is employed -- ultimately [ these limit ] credit exposure.
On Slide 14, we present our historical look back on migration performance, which shows over the last 3 years, [ WAL rates 4 ] for approximately 1/3 of the peer median on net charge-offs to average nonperforming loans. Over the past decade, we ranked #1 at only 9.6%. The table on the right shows our allowance numbers over 7x in the last one net charge-offs, inclusive in the second quarter and places us in the top third among peers. Our ACL also covers our last 4 years of net charge-offs, which is the duration of our loan book by 4.3x, which is the second best in the peer group during this timeframe.
Our CET1 ratio remained 11%. Our tangible common equity ratio of the total assets moved down approximately 10 basis points from Q1 to 6.7% as asset growth and low-risk categories exceeded organic capital accretion from higher earnings. I think it's helpful to consider other sources of loss absorbing capital when evaluating our balance sheet -- viewing our CET1 capital ratio with AOCI marks and loss reserves as a percentage of risk-weighted assets, we ranked in the top 1/3 of our peer group. Notably, among the 6 peers on Slide 14, with higher ACL to net charge-off ratios over the last 12 months, only 2 have higher adjusted capital ratios than WAL.
Finally, tangible book value per share increased to $1.49 from the end of Q1 to $48.79 from retained earnings growth, which equates to an annualized growth rate of approximately 13%. Our consistent upward trajectory and tangible book value per share has outpaced peers by 7x since the end of 2013.
I'll now hand the call back to Ken.
Okay. Thanks, Dan. Following our Q2 results, I would like to update the bank's 2024 guidance as follows: a building pipeline provides clarity to continue loan growth at $1 billion per quarter in a safe, sound and thoughtful manner. Our current loan-to-deposit ratio provides flexibility to selectively make more loans as opportunities arise. For the full year, loans are expected to grow $4.5 billion compared to the $4 billion previously, and deposits are expected to grow $14 billion, which is $3 billion above our previous forecast. Deposit growth in Q3 is expected to be $2 billion.
Turning to capital. We expect our CET1 ratio to remain at or above 11%, capturing the forecasted increase in loan volume as organic earnings growth supports rising loans and investments. Net interest income is now expected to grow 9% to 14% from the Q4 2023 annualized jumping off point. Our rate outlook includes two 25 basis point cuts in the back half of the year. NIM is expected in the 3.60% area for the remainder of the year, and Q2 ending loan balance versus the average for deposits and loans provides continued net interest income momentum for the back half of the year.
Noninterest income should increase 15% to 25% from adjusted 2023 baseline levels. Our upward revision reflects growth in commercial banking fees as well as incremental improvement in other fee segments. Noninterest expense, inclusive of the ECR-related deposit costs is now expected to rise 9% to 13% from an annualized adjusted Q4 baseline of $1.74 billion primarily from the greater ECR-related deposits, which fund attractive balance sheet growth and grow earnings.
In aggregate, these factors should enable WAL to sustain PPNR, to provide the organic capital to support balance sheet growth and the CET1 target, while offering us the ability to maneuver around various economic and operating environments. Asset quality is normalizing from historic lows and net charge-offs are expected to remain low by industry standards at 15 to 20 basis points of average loans for the year.
At this time, Dale, Tim and I will take your questions.
[Operator Instructions] Our first question today comes from the line of Jared Shaw with Barclays.
Maybe just looking at the loan growth, you've had great loan growth, obviously, this quarter. As we go forward, any change in sort of the geography of where that's coming? You look at the CRE portfolio that's been a little bit under pressure. Should we think that it still is coming from the same primary areas of C&I? Or could there be an expansion into some other areas?
Yes, thanks. Well, for the year and also for the quarter and also year-over-year, the majority of our growth has been coming in the C&I categories. And again, that's in a no or low loss loan segment. And I think we're going to continue to move forward in that manner. I think what you can expect for the rest of the year is to see continuous downward movement in our residential loan portfolio as you saw this quarter. I think you'll find CRE overall will be relatively flat. We will look for opportunities to finance -- we do like pockets of financing in the construction land and development. Most notably, we've always talked about this a lot banking segment will provide opportunity. But the short answer, I guess, is that mostly it's going to come in C&I, node financing, warehouse lending are the 2 areas that are going to lead the way.
Okay. And then just on the fee income side, are you assuming -- I guess, you're still assuming that the Fed funds cut flowing through to help with mortgage banking there as well? I guess what's the trajectory we could expect there following that -- those 2 cuts?
Right. So for our forecast, we have a rate cut in September and a rate cut in December. We are forecasting a modestly declining mortgage income, mostly because the Q4 rate cut, yes, it comes in a quarter that's seasonally low in terms of volume. So we would expect to see pickup from the rate cut in terms of mortgage volume really following to 2025 more so as a back end of Q4. So it's basically Q4 is a seasonally low quarter to begin with.
Our next question comes from Steven Alexopoulos with JPMorgan.
Let me start on the ECR deposits. Can you just give more color on what drove such strong growth? And was the increase in the interest expense on those purely tied to the growth? Or did the rate -- the effective rate basically rise as well?
Two questions there. So first, the growth came in warehouse lending, all right? And what we have found from the first quarter disruption in the market, that Western Alliance's warehouse lending group has become really the premier platform to hold your escrow accounts on and also come to us for warehouse lending and MSR loans. So that volume is coming in for that reason. Also, we've had a number of market share gains, new clients coming in, that's one type of market share gain, and existing clients that we currently have given us more of their deposits. So that's kind of push on that segment, which carries a higher ECR.
Now with that liquidity, we've been paying down and we'll continue to pay down our short-term borrowings. And to your other question, we do have several initiatives that we are launching to kind of work on the rate and see if we can push that rate downward as we go into Q3 and exit Q4.
Okay. That's helpful. Ken, in terms of the deposit growth getting lifted again, were you guys just very conservative? Is growth coming in much more than you guys expected, and it's funny, when we look at the second half, you did $11 billion of deposits in the first half. I think you're guiding like $3 billion in the second half. I know there's some seasonality in the fourth quarter, but you're just being very conservative here.
So let's talk about the seasonality first. In warehouse lending, we see an outflow of deposits every Q4. So some of the deposit growth in Q1 of 2024 was the return of those tax escrow payments that were made. And usually, that runs between $3 billion and $4 billion that flows out in Q4. So why I'm saying $3 billion net growth, then you can see that we're accounting for the $3 billion to $4 billion that's going to fly out the door or flows out the door at the end of the year. Where we're getting it from is -- what's interesting is for this quarter, as an example, 58% of our growth really came from our deposit-only channels. And so we've launched a number of them, as you probably know, business escrow services, Corporate Trust, Juris Banking, and of course, HOA, which started about 12 years ago when I first got -- first joined the bank. And that's where the deposit vertical growth is coming from.
In addition, our consumer lending or consumer digital platform has really taken off, and we're doing quite well there. And we had another strong quarter in Q2, and we saw deposit growth growing $673 million. So since we actually launched the consumer digital channel, I'll give you a number as of today, because our folks are very proud of it, that they just shopping [ you note ]. But inside of 1.5 years, that channel has moved up to about $4.5 billion. It just provides another channel for us that we didn't have before, at cost point or price point, which is rather consistent with our commercial pricing, right? So we don't have a consumer base, as you know. So we don't have to worry about cannibalizing our consumer base and having them move from low rates to higher rates. Here, it's consistent with what's happening in our commercial book. And it provides another channel for us to use almost as a challenger channel to other deposits that are coming in to hold the line or try to push those deposits down over the long-term.
Our next question comes from the line of Ebrahim Poonawala with Bank of America.
I guess maybe as we think about lower rates and the NII outlook. Dale, If you don't mind reminding us, including the ECR-related deposit costs, how should we expect sort of NII to trend if those rate cuts from September and December continue into '25? Is that positive overall for the NII in NIM, inclusive of ECR or negative?
And secondly, what determines whether you end up at the 14% versus the 9% for this year on NII outlook.
So yes, just regarding your first inquiry, Ebrahim. Yes. So we're fairly neutral on an aggregate of net interest income plus our deposit expenses. And maybe as Ken was alluding to earlier with the discussion about our mortgage operation, we're not sure that, that's really going to kick in until we get a little more than 1 for the fourth quarter and then 2 moving into the beginning of 2025. A little more rate relief on the mortgage rate environment. So we feel comfortable with where we are. And I think within the relevant range that we're going to see later this year, we're going to be fairly neutral on -- I'm going to say, PPNR related to interest rate movements, both inclusive of interest expense and deposit costs.
And I'll take your second part of your question, which is what factors influence how we will perform in the second half of the year. I think you can expect Q3 that you'll see net interest income continue to rise, and then in Q4, you can expect net interest income more or less to be flat to Q3. And one of the factors there, one is our continued upward movement in loan growth. That's very important. And overall, our total revenue should, in Q4 should be relatively flat to Q3. So we are making up some of the decline in yield by having higher volume in loans and also working some other fee-based channels that we have. And then we've been working on those fee-based channels and developing them over the last year.
Got it. And I guess just a second question, Ken, I do want you to address from a credit standpoint, these are really low number as I get it. But it's been overhang on the stock for 3 or 4 years. Just talk to us outside of things going through the pipe, your visibility in terms of credit quality outlook over the next 6, 12, 18 months, where do we -- where do you anticipate some weakness, drivers of losses ex all the things that you have said are no loss kind of pieces of the loan book? I would appreciate that.
Yes. I'm going to Tim take that one.
Yes, thank you. So Dale, I think did a nice job of really covering some key measures of success in the portfolio in his discussion. So I'd start by saying we're very pleased with our portfolio performance. And then when we look forward, the -- we've taken every opportunity to describe, we focus on early elevation and early resolution. So we really take a forward-looking approach when we view troubled loans, portfolio performance and our ACL. So our forward estimates that Ken talked about, at 15 to 20 basis points, include all current valuations, anticipated value-based changes to carry assets that may default and are based on the market conditions that we're living in today. So we update these values and assess each exposure always on an ongoing basis.
Our next question comes from the line of Brandon King with Truist Securities.
Just a follow up on the credit conversation. So the guide implies some increase in net charge-offs for the second half of the year. But I just wanted to get a sense of what changed from last quarter to imply kind of a higher run rate.
Yes, I think we really look at this all the time as a forward-looking estimate and we really didn't make a significant change in terms of percentage or dollars. We update based on current conditions, and we'll continue to do that. So from our standpoint, we're optimistic, and we are maintaining really a stable outlook on our portfolio. So we update our appraisals on our nonperforming loans of approximately every 6 months. And we're getting more clarity. Some of these markets don't have a lot of transactions. And so as that comes in, we saw something in terms of the San Diego property we took back immediately. You see that here, that put us a little bit above the 15% kind of upper limit that we had as of our first quarter guidance. And so we expanded that to kind of 15% to 20%.
Okay. And just a follow-up on the San Diego loan. Could you expand on kind of the update there, news about being foreclosure and kind of your plan to deal with the asset?
Yes. Look, we were moving to foreclosure. We took the appraisal charge, as we described. We are going to work to reposition the asset increased occupancy. And then we'll also look to sell the building when we have the occupancy level at a higher level than it is today. So it's what you would expect anyone to do. Think of it as acquiring -- think of it as you going out and buying a property, what would you do to enhance the value. That's what we're going to be doing.
Okay. And then just lastly, really leaning into some mortgage warehouse deposits. Any thoughts around concentration levels? I know it's continuing to creep up there. But how do you feel about the concentration of your total deposit base, particularly within mortgage warehouse?
Yes. So there's good news and interesting story here, okay? The good news is, as we continue to become one of the premier platforms in the industry, we're seeing all these deposits come in. That's great. We are also getting market share wins. That also is great. The flip side of that is a higher concentration. And so you've seen our HQLA grow. And so we are not putting all of those -- all that liquidity out to finance loans, but rather holding that liquidity on our balance sheet and making a smaller spread.
What we will do over time is work with our clients to work through or repositioned current pricing models given the liquidity that we have. So a year ago, there was a premium placed on liquidity. And people said, "If you want my liquidity, you have to pay up for it." Well, things have changed a little bit now. And as a premier platform, I think there's a discount that people have to take when coming to our platform for our service levels. The ability to do multiple things, not only handle their escrow deposits, but also provide financing. And we're going to see if they value it that way. And so we're going to work in that particular segment to scale down or push down some of the rates that we're paying.
The growth we've had is a great problem to have, and it gives us flexibility on leverage to be more aggressive in this repricing initiative that's underway.
Our next question comes from the line of Timur Braziler with Wells Fargo.
I'm wondering if you can provide us with an update on the large financial institution spend kind of what's left to be done there. And I'm just wondering if the faster growth rate of the balance sheet, what that implies for the timing of completion on some of those projects?
Yes. So we've indicated in the past that we're approximately 3 quarters of the way through with complying with where we need to be to tip over $100 billion. I wouldn't extrapolate too much from our growth rate for the past few quarters and say, make that trajectory in terms of where we're going to cross over $100 billion. We still have had about $6 billion of borrow funds, about $6 billion of broker deposits, and we're going to be paying that down in a more accelerated fashion. So you're going to see our total assets grow at a slower rate than what you've seen over the past few quarters.
That said, though, we're well on track with this. We're developing whatever plans we need to finally get that we do not see a significant step variable costs in front of us to be able to get over that, except for potentially what is related with a TLAC, total loss absorbing capacity, we need to do more debt there. But even in that situation, based upon a [indiscernible] prototype, which I think is being revised, we had until '28 to kind of get there.
Got it. And then maybe just following up on Ebrahim's question around rates. I guess how would the cadence of rate cuts potentially impact your ability to lower ECR costs and benefit some of the other mortgage-related activity, i.e., if we just have one rate cut or if the rate cuts are spread out, how would that affect your ability to maybe lower some of those ECR-related expenses?
Look most importantly, the [indiscernible] is broken on rates. I mean, so there's no places where others can go and get kind of substantially higher rates as we had when we were in an expected higher rate environment, if you go to treasuries or some of these other products and to be a competitor against deposit rates plus the situation within the banking space has become somewhat more relaxed as well. However, these are entities that control significant amounts of dollars, and so they can get something at or near what would be kind of the market rate of interest.
But as I said earlier, I mean, we're in a position that we can, I think, start to kind of use our leverage with our strong balance sheet, with our strong delivery system within this space that we think we're now kind of the premier player to be able to effect a more significant cost mitigation strategy going forward.
But a simple answer as rates move, total ECR rates of the Fed cuts 25 in September, you'll see that flow through, starting immediately.
Got it. And then maybe if I could just sneak one more question in around mortgage banking. There was a comment in the release on maybe elevated loans held for sale and doing more conforming mortgages. And then in the deck, part of the rationale for the higher fee income guide was that margins are firming up. It looks like gain on sale margin actually declined a little bit here. But are we starting to reach an equilibrium kind of with the new production? I guess what are the expectations for gain on sale margins in the context of the 2Q decline?
Yes. So gain on sale margins in Q1 were higher than Q2. In Q2, you saw mortgage rates move back up above 7%. They're firming now, and we are optimistic, but we don't have it captured into our forecast yet that as more people get comfortable with that rate cuts are coming and with the shortage of supply and housing in the market that more people will start returning. They're seeing a little pickup now in refi activity, but we're looking forward to the purchase activity to really drive us. But from a forecast point of view, we're going to wait to see that flow through our P&L before we capture it in our go-forward consensus outlook.
Our next question comes from Matthew Clark with Piper Sandler.
Maybe just on the margin. It held up a little better than expected, up 3 bps. I think you had guided previously down 10 and that's despite kind of loans to earning assets coming down. Updated thoughts on kind of the near-term margin outlook?
Yes. So we did pop it up 3 basis points. And again, with the excess liquidity, we did 2 things. With -- a lot of excess liquidity came in towards the back end of the first quarter, so we're able to deploy the average earning assets, that helped. And then also, we're paying down our -- and working hard to pay down our short-term borrowings. As I said in my prepared remarks, going forward, Q3, Q4, you can see net interest margin holding very close to where we are now in the 3.60% area, and that includes the 2 rate cuts.
Yes. Got it. And then just shifting gears to credit. Any color on the uptick in special mention this quarter. What drove that increase?
Yes. We're really -- it's a balance with the prior 4 quarters of last year. So we were down from where we spent most of the year last year. Slight uptick, and it's just part of our early elevation as part of our ongoing review processes. I say that it was idiosyncratic or specific deal situations that brought credit into view. And then we will quickly as we always do, work through those to move them up or out.
Yes. I would note that whether you're looking at the special mention ratio or total dollars, Q2 was still below the trailing fourth quarter averages. So nothing out of the ordinary in that special mention move.
Our next question comes from Bernard Von Gizycki with Deutsche Bank.
So just a question on your interest rate sensitivity disclosures. I believe you might have made some changes in the 1Q disclosure versus the 10-K, given more granular assumptions on the deposit betas. So for 100 basis points decline in rates, you showed NII down about 7% at [ 3/31 ]. But I wonder if you could update that at 6.30% and believe NII could come in better given higher expected loan growth and benefit from wholesale deposit repricing. So I just wanted to see if you could provide some puts and takes there.
Well, okay, so net interest income should come in higher as what you just said. But the volatility around that on a different interest rate assumption, again, this is a shock that we show, it's probably going to be fairly similar to what we showed you in the first quarter. So not a whole lot of difference there. And again, I mean we look at it really looking at net interest income plus the delta that we're going to see in deposit costs, which is going to have kind of the opposite effect. And so the net between them gets to a fairly stable, I'll call, net interest-related items in PPNR combining those 2 elements.
Got it. And then just separately, just on the fee income, just a question on this. I know the equity investments were about $4 million, which were much lower than the previous 2 quarters. And I think there's some benefits on warrant income in prior quarters. Just wondering if you can provide any color -- any expectations from here going forward?
Yes. That's a difficult thing for us to really prognosticate, and so we have equity positions in more than 500 companies. And which ones top or which ones to close is a process on how that looks. I mean there is some correlation with maybe M&A activity. That's been a little restrained for reasons that I think everyone is aware of. So maybe that's been a factor here. I can't really project what it's going to be in third and fourth quarter other than we don't see anything really change going on. So we can -- maybe we've got the parameters of where the higher or lower areas could be and maybe somewhere in there. But there's nothing going on there that we think is going to be a magnitude change either better or worse, respectively.
Our next question comes from Chris McGratty with KBW.
Dale, if I look at your guide, in the ranges in your guide, it would seem that if you're at the midpoint of NII, you'll probably be at the midpoint of the expenses or the high end to high end. Is there a scenario where you're perhaps at the high end of expenses and then maybe the midpoint of NII? Or should we just think about them whatever our assumptions are they should be kind of consistent?
I mean I wouldn't put too much interdependence on the elements in here. There is a correlation, obviously, if net interest income moves up, what does that mean? Is that a relatively higher, either rates overall, maybe fewer rate cuts and/or better growth, and that can affect what's going on, on the expense side. But in total, I mean, I think these parameters are reasonably pretty fair. I mean, if anything, we're -- maybe we think we're going to do a little better on the noninterest income side, maybe towards the upper end of that range, but the others, I think, I think kind of a midpoint is fairly on target with what we would consider.
Okay. That's helpful. And then on the -- just going back to the balance sheet strategy. You talked about the expense build and HQLA and TLAC -- the capital target, the 11% plus that you've been with for the better part of the year, is there a scenario where that changes in your view materially either way now that you're kind of through the -- or through the worst of the crisis, and were a little bit more confident in your outlook?
Chris, you blanked out. You -- we missed the first part of that question. Could you repeat it for us, please?
Sure. I guess just closing the loop on the $100 billion investment discussion. Is there a scenario where your 11% CET1 target, I guess, would move materially one way or the other, I guess, is the question.
So we want to keep the 11% as a target, more or like for, as we've said before, growth that we're generating from earnings are going to be used to fund loan growth. So the progression from the CET1 level, 11% upward is going to be slower. It's not going to be as rapid as you've seen in the last 6 or 7 quarters. And we -- if you're asking is there a stock repurchase program in our immediate future, the answer would be no because unlike many of our peers, we have a higher degree of comfort regarding loan growth coming from these low or no loss loan categories that we think, over the long-term, will propel the company forward at a faster rate for EPS. So that's what we plan to do.
Yes. I actually wasn't -- for this time, I wasn't asking about the buyback, it was just more about balance sheet leverage and growth, but got you on there.
Our next question comes from Samuel Varga with UBS.
I wanted to ask a question about the Corporate Trust business. Could you give us an update on where things stand, sort of where are the pipelines. You mentioned that the investment-grade rating is the catalyst here? Can you just give a broad update on where that business is at.
Yes. So yes, I think we're the only bank -- I'm pretty sure we're the only bank that has had positive ratings actions, if you want to call them that, from either Fitch or from Moody's. So we're both on outlook positive. Obviously, our ratings are not where we believe they should be. But we think that is encouraging in terms of direction. We have gotten certainly good traction in our Corporate Trust operation, and we've tag-teamed with our corporate finance group, and deliver a combined product set for CLO administration, which we think has been helpful.
So we're really quite optimistic of what that looks like while I would be glad to have a ratings increase on -- for both of those entities, we don't think it's necessary for us to continue to grow strongly in that category. We have more than $0.5 billion in deposits there presently.
So I was on the road last week with the Corporate Trust Group and our lender finance group. And combining those 2 together when calling on clients has put a pipeline of deals ready to close, not -- do not mean these deals have been mandated to us, of about -- there's like a pipeline of 30 clients that's [indiscernible] close. And so putting those 2 things together has been very, very valuable where we have the ability to make investments or lend on the lender finance side. And as we do that, we expect the mandate on the Corporate Trust side.
But what's more importantly is the Corporate Trust program that we built. We took a few people from the large money center bank, after chatting with them during the interview process, I said what is needed to make this program successful and it really was rebuilding the technology, the architecture that's currently out there and a higher level of customer service. And I can tell you from the 5 or 6 calls I had last week, that is exactly how our clients feel about, that we have the better technology in the industry and the service levels are meeting their expectations, is actually not exceeding them.
So it's pretty exciting for us. We're going to see how this thing moves forward. This is a build, so our Corporate Trust group in terms of deposits should do between $150 million to $200 million on average a quarter. And as our name gets out there and we continue to expand the group, I would hope for bigger and better things as we move into 2025. But right now, very, very pleased with that activity.
Great. And then I just wanted to switch back to ECR deposits for one last question on that. Dale, if I understand correctly the mortgage warehouse deposits are sort of pulling up that paid rates. Is it fair to assume that if 4Q seasonality comes through and those deposits partially slow out that, that alone will be enough to reduce the ECR rate regardless of whether we actually get cuts or not?
Sure, sure. So first off, I mean, as Ken alluded to earlier, we're expecting 100% or a little bit above deposit rate or, I would say, funding cost beta on the ECR as rates come down. And so if you get that effect and then coupled with an expected outflows seasonally not related to relationships in the fourth quarter, both should have a combined effect going from, say, a rate cut at their meeting in September into the fourth quarter, lower rate and lower balances, you're going to see a drop in noninterest expense.
Which gives us the confidence level that our EPS, as it -- as we move through Q3 and into Q4, we'll be on an upper trajectory, which is what we've been communicating since the beginning part of the year.
Our next question comes from the line of Jon Arfstrom with RBC Capital Markets.
A couple of questions here. Can you guys talk about the competitive environment in your mortgage businesses? It seems like it's changed. You've kind of alluded to it, you've taken share. Just curious what happens when volumes pick up and how you take advantage of that?
Okay. So what I'm talking about is the warehouse lending group, not the AmeriHome Group, right? That's going to be more and more dependent. But in the warehouse lending group, we've seen a couple of competitors recently dropped out of the market. One has said that they're selling loans, on sold loans. And what's most important to our clients, and maybe this is really when people always say, why is it that you guys grow while others don't? Well, first is that we're a commercial bank, and we're national, and we just don't stick to a region. So that's one answer. The second answer is, we don't move in and out of markets, and people can count on us to always be there.
Now terms and conditions may change because economic conditions change, but we don't pull out of the market and then jump back in. And our clients remember that, especially around warehouse lending, where those lines sometimes can get shut down rather quickly and larger banks can make a determination of whether or not they want to be in the business or not. And that's a little bit more serendipitous. For us, we want to be in the business and we've got the economic terms and operating conditions tell us what it is we need to charge and how to be there to support our clients. And I think that's one of the reasons why we've become a premier go-to platform in that segment.
Okay. What -- there's been a lot of discussion on interest rates. What do you guys prefer from a rate perspective, do you want a couple of cuts? Do you want more than a couple of cuts? What's ideal for you?
Boy, that's a question for me and my therapist. But for the most part, if rates keep coming down at a faster pace, what we would look for is the mortgage fee income to rise and that we can bring in volume on the loan side to help offset some of the rate decline that you would see on our loan portfolio. And that would be the -- that would be our approach. Dale, do you have a different opinion?
No, I agree. The other thing I would say is it's been a little bit about -- you can still think of this rate, the Chinese water torture on CRE, in particular, related to a higher rate environment where debt service costs is just -- has become burdensome over time and it's little the way at DSCR, debt service coverage ratios for the past few years and LTVs as cap rates have climbed. So relief on that, I think, would give the whole industry a little bit more headroom in terms of NPA materialization and issues related to maintaining strong asset volume.
Okay. Okay. Fair enough on that. And then, Dale, just a quick one on the provision. Given the updated charge-off guide and the growth guide, I think it suggests a relatively stable provision. Am I looking at it the right way? Or is there something else to consider?
I think that's it. I would say, however, I mean, look, we've had good loan growth. We've had -- our loan-to-deposit ratio on a marginal basis for the past couple of quarters has been very low. We've kind of planned into our comfort level in terms of our liquidity profile. So if we had higher loan growth, you know how CECL works, of course, that demands the load up on provision costs irrespective of what earnings you've been able to draw from that in the present area.
Which you saw in this quarter.
We have no further questions. So I hand the call back to Ken Vecchione for closing remarks.
Yes. Well, thank you all for joining us. We feel very good about the quarter. Just a very special thank you to the 3,600-plus people that work throughout Western Alliance, they made this quarter happen and a big thank you to them, and we look forward to our next conference call. Be well, everyone.
Thank you, everyone, for joining us today. This concludes our call, and you may now disconnect your lines.